Income velocity and non-GDP transactions in the UK

Iris Biefang-Frisancho and P.G.A. Howells

International Review of Applied Economics, 2012, vol. 26, issue 1, 97-110

Abstract: It is widely reported for many countries, including the UK, that income velocity has been highly variable around a declining trend in recent years. This paper advances the following hypothesis. The demand for credit and hence the broad money stock are influenced by total spending in the economy, rather than spending only on newly produced goods and services. Since total spending in the economy has generally increased relative to GDP (mainly because of asset transactions) credit and money have expanded more rapidly than GDP, with the resulting fall in income velocity. Using quarterly data from 1975 to 2008, we estimate a vector error correction with income velocity as the dependent variable and the ratio of total to GDP transactions as an explanatory variable. The results show substantial support for the hypothesis and raise (further) doubts about the information content of broad money aggregates for inflation targeting central banks.

Date: 2012
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DOI: 10.1080/02692171.2011.580270

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